When social enterprise goes bad

The social ills of the Philippine economy—rampant unemployment, poverty, the income gap, and a high degree of extralegalism—are the focus of a great deal of well-meaning attention (at least from people not associated with the current Administration), and that’s good. But socially conscious aspirations are not enough, as this cautionary tale from South Africa should remind us:

Back in 1998, an investment firm called Theta Securities owned by two South African business partners, Leon Kirkinis and Gordon Schachat, bought the securities license of a failed bank called the African Bank, and over the next year absorbed three small lending banks to create African Bank Investments Ltd., or ABIL.

ABIL’s business was almost exclusively uncollateralized lending. Kirkinis had a vision to expand formal credit to South Africa’s poor, and for a long time it worked; ABIL became

South Africa’s largest lender of uncollateralized loans – a high-risk segment typically handled by microfinance and rural banks, characterized by relatively small loans at high (some as high as 60 percent) interest rates – and registered healthy profits in the process. In 2012, which was ABIL’s high-water mark, the bank was able to pay a healthy dividend of 1.95 ZAR (about $0.18 or P8) per share. Kirkinis himself was also doing rather well; according to a Bloomberg report, ABIL’s success had allowed him to amass a share in the bank worth 660 million ZAR (roughly P2.7 billion), pushing him into the top 40 of South Africa’s wealthiest people.

It all ended in tears last month, when on August 6 Kirkinis resigned from ABIL after announcing the bank was about to post a record loss and would need 8.5 billion ZAR ($790 million) to balance its books. On August 10, the South African Reserve Bank intervened, absorbing 7 billion ZAR in bad loans from ABIL (as many as one in three of the loans the bank had made had defaulted), suspending ABIL’s stock shares and bonds, and putting together an underwriting consortium of seven commercial banks to provide 10 billion ZAR in recapitalization. Most of ABIL’s investors expect to lose everything, although the central bank is said to be working on a plan to allow senior debt holders to recover at least some of their investment.

What is most interesting about the ABIL story is that its model not only worked for a time, but worked well. Until 2010, the bank did not have deposit operations, and relied entirely on the bond and equity markets for continued funding of its lending program. As long as things were going well, that approach was effective, but in 2008 ABIL acquired the financially shaky Ellerines Holdings Ltd., the parent company of a chain of furniture retailers throughout South Africa and the neighboring countries of Namibia, Swaziland, Lesotho, and Botswana.

Ellerines catered to the same sort of lower-income, credit-isolated market ABIL did, offering furniture and appliances on very loose (but very expensive) installment credit terms to consumers. Outwardly, the acquisition was a good move for ABIL in terms of expanding its market reach, but the growing amount of bad debt Ellerines was gathering should have been a warning sign. Ellerines soon became a sinkhole of funding for ABIL, and it would take just a little push from the wider economy to drive the bank itself over the edge.

That happened in mid-2012 when a series of strikes virtually shut down South Africa’s platinum mining industry. ABIL’s customers began defaulting on their loans at an increasing rate, and in February 2013, the bank was forced to postpone a bond issue due to growing criticism of its ‘reckless’ lending practices, criticism which eventually led to ABIL’s being hit with a 20 million ZAR fine in October 2013 by the central bank for issuing more than 700 loans without following proper affordability assessment procedures.

In July of this year, ABIL finally announced that it was seeking to unload Ellerines, which gave a momentary boost to the bank’s faltering stock price, but it was too late; unable to find a buyer, the bank announced it was cutting off funding to its furniture subsidiary the same day Kirkinis resigned, and applied for “business rescue” (the South African term for bankruptcy) for Ellerines the following day.

Here in the Philippines, the government has recently loosened restrictions in the banking industry to allow more foreign investment; both the rural banking and microfinance sectors are growing at a respectable rate, and more significantly, so is the “unconventional” financial sector that consists of services like Globe’s GCash, Smart Communications’ Smart Money, and a variety of other systems that allow a far greater number of people to have access to some semblance of formal banking services.

And why not; with about half the workforce being underemployed (according to a recent study by the government’s own economic think tank), the informal economy in this country is huge; fertile ground for any investor who can tap into it in an organized way.

The concerned agencies in the Philippines—primarily the Bangko Sentral ng Pilipinas (BSP) and the Securities and Exchange Commission (SEC)—may believe they have sufficient safeguards in place to prevent something similar to the ABIL collapse from happening here. Perhaps they do, but if there is one big lesson in the ABIL saga it is this: If the Philippines’ financial sector evolves as quickly as everyone hopes its present economic circumstances are suggesting it will, monetary authorities and corporate overseers cannot let their guard down for an instant, and must be capable of and prepared to evolve more quickly than the industry to be reasonably confident disaster can be averted.

That is because the collapse of ABIL, a relatively small lender in the bigger scheme of things in South Africa, has had some far-reaching, nasty repercussions. About two weeks after Kirkinis’ departure from ABIL, ratings giant Moody’s downgraded South Africa’s four largest banks (Standard Bank, FNB, Nedbank and ABSA, which is owned by Barclays) because of their risk exposure, and warned more ratings reductions—including possibly even South Africa’s sovereign rating —may follow.

The tailspin the ABIL crisis caused South Africa’s bond markets compelled a number of companies, including the South African division of Toyota Motors, to push planned debt offerings, which could lead to a slowdown in the wider economy in the next couple of quarters.

ABIL was the proverbial “bad apple,” and as the old saying goes, all it takes is one. Fortunately, there does not appear to be an institution at risk of becoming this country’s ABIL at this point, but that could change quickly. Policymakers and the business community should take heed not to allow chasing growth to lead them into tossing caution to the wind.

2 Comments

While a private sector set of corporations, the ABIL group’s burst was similar in a microcosmic way to what happened in the US and then the world with the burst of Freddy Mac and Franny May, isn’t it?.

It was, and what is kind of disturbing about the whole thing is that it happened at a time at which everyone should have already known better — most of the trouble occurred well after the worst part of the 2008 global crisis had passed — and the man behind it all, Leon Kirkinis, should have definitely known better, because he is personally as well-qualified and experienced as any top-flight banker anywhere in the world. I think the big lesson here, and the one people in this country really need to take to heart, is not to become complacent. In hindsight, the non-depository lender model actually looks pretty stupid. But its success for a while blinded both regulators and the industry to the risks and implications of it. I don’t see anything like that happening here, but I can definitely see how it easily could, and that is cause for concern.